AI Drafter 
TaxTMI 
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TaxTMI 
2019 (8) TMI 31
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.... (11) TMI 884 - AUTHORITY FOR ADVANCE RULING, MAHARASHTRA BRIEF FACTS OF THE CASE A. The Appellant is a non-banking financial company and is inter alia engaged in providing various types of loans to the customers such as auto loans, loans against the property, personal loans, consumer durable goods loans, etc. B. The Appellant, inter alia, enters into agreements with borrowers/customers for providing loans to them. The loan agreements provide for repayment of the outstanding dues/ Equated Monthly Installments (EMI) through cheque/ Electronic Clearing System CECS')/ National Automated Clearing House ('NACH') or any other electronic or clearing mandate. The illustrative copies of loan agreement entered into between the Appellant and the customers have been enclosed with the Appeal. C. The installment of a loan is computed taking into consideration the amount of loan, rate of interest, duration for a loan etc. Generally, EMI paid by the customer is a fixed amount paid at a specified date. EMI includes the amount of interest and the principal amount. D. In case of delay in repayment of EMI by the customers, the Appellant collects penal/default interest (hereinafter refer....
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....06.2017, and Sr. No. 28 of Notification No. 9/2017-lntegrated Tax (Rate) dated 28.06.2017? ii) If the answer to the above is negative, whether the activity of collecting penal interest by the Appellant would amount to a taxable supply under the GST regime?" H. The AAR passed the Order No. GST-ARA-21/2018-19/B-24 dated 06.08.2018 = 2018 (12) TMI 1154 - AUTHORITY FOR ADVANCE RULING, MAHARASHTRA (hereinafter referred to as 'impugned order'), holding that the penal interest charged by the Appellant amounts to supply of services under Sr. No. 5(e) of Schedule II to the CGST Act, and is therefore liable to GST. I. Aggrieved by the impugned order dated 06.08.2018, the Appellant has filed this appeal, inter alia, on the following grounds which are urged without prejudice to each other. GROUNDS OF APPEAL 1. The impugned AAR order is a non-speaking order and is liable to be set aside on this ground alone. (i) Without prejudice to the submissions that the penal interest is an additional interest on loan, such penal interest is liable to be included in the value of main supply under Section 15(2)(d) of the CGST Act, and therefore, any treatment given to the main supply ....
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....S.C.) = 2010 (10) TMI 660 - SUPREME COURT • Asstt. Commr., Commercial Tax Department v. Shukla & Brothers, 2010-TIOL-131-SC-CT = 2010 (4) TMI 139 - SUPREME COURT • Commissioner of CGST & Central Excise v. M/s. Development Credit Bank Ltd., 2018-TlOL-2313-HC-MUM-CX 4. It is an undisputed fact that the Appellant is an NBFC which is engaged in providing various types of loans to the customers such as auto loans, loan against property, personal loan, consumer durable goods loan, etc. Further, it is also undisputed that interest on loans have been kept outside the levy of GST, under Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. The relevant portion of the said Exemption Notification is reproduced herein below: Sl.No. Chapter, Section, Heading Group or Service Code (Tariff) Description of Services Rate (per cent.) Condition (1) (2) (3) (4) (5) 27 Heading 9971 Services by way of- (a) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services); Nil Nil 5. In view ....
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....URT, the Constitution Bench opined that a person deprived of the use of money to which he is legitimately entitled has a right to be compensated for the deprivation, call it by any name. It may be called interest, compensation or damages.... this is the principles of section 34. In Dr. Shamlal Narula v. CIT [1964] 7 SCR 668 = 1964 (4) TMI 10 - SUPREME COURT, this Court held that interest is paid for the deprivation of the use of the money. The essence of interest in the opinion of Lord Wright, in Riches v. Westminster Bank Ltd. [1947] 1 All ER 469, 472, is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had the use of the money, or, conversely, the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation; the money due to creditor was not paid, or, in other words, was withheld from him by the debtor after the time when payment should have been made, in breach of his legal rights, and interest was a compensation whether the compensation was liquidated under an agreement or statute. A Division....
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....he profit or advantage of the creditor which he gets by giving to another the use of his money. If the contract stipulates that for the use of the creditor's money a certain profit shall be payable to the creditor, that profit is interest, by whatever name it is called, or if it is called by no name at all. Applying Act 4 of 1938 to the present contract it is clear that the principal is Rs. 2500. The only payment was an open payment of Rs. 150 made on 23rd July 1931. The whole of the interest as on 1st October 1937 is cancelled and the creditor is entitled to Rs. 2350 with interest at 61/4 per cent. per annum from 1st October 1937. The appellants are entitled to their costs here and in the Court below." Similarly, in the case of V. Srinivasachariar v. Conjeevaram Hodgsonpet Dharamarakshaka Nidhi Limited, 1940 AIR (Mad) 937 = 1940 (8) TMI 32 - MADRAS HIGH COURT, the Hon'ble Madras High Court held as under: "3...........I proceed therefore to such an examination and I find that towards the sum of Rs. 1,500 borrowed in February, 1927, a sum of Rs. 1,396-3-3 has been credited as part repayment. The suit is for the balance, namely, Rs. 807-13-2 and the accounts have been....
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.... used or retained on payment of interest or on a discount. The words used are 'deposits, loans or advances' and have to be taken in the generic sense. They would cover any facility by which an amount of money is lent or allowed to be used or retained on payment of what is commonly called the time value of money which could be in the form of an interest or a discount. This entry would not cover investments by way of equity or any other manner where the investor is entitled to a share of profit. Illustrations of such services are - • ........... • Providing a loan or overdraft facility or a credit limit facility in consideration for payment of interest. • Mortgages or loans with a collateral security to the extent that the consideration for advancing such loans or advances are represented by way of interest. • .............." 13. On conjunctive perusal of the above, it can be understood that "interest" represents the time value of money, and any amount received in lieu of usage or retention by one person of a sum of money belonging to another is nothing but interest only. 14. In the present case, the Appellant is prim....
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....d the stipulated period of time by the borrowers. Therefore, penal interest is nothing but interest only. 17. It is further submitted that there is no distinction in law for 'principal interest' and penal interest'. The definition of the term 'interest' given in clause (zk) of para 2 of the Exemption Notification covers interest payable in any manner, and therefore, even the penal interest is covered within the scope of 'interest' for the purposes of the GST law, and hence, the same shall be exempt from GST. 18. However, the Ld. AAR in the impugned AAR order has held that the penal interest is not interest on loans. In this regard, the Ld. AAR has recorded a finding that the penal interest has been termed as 'penalty' in the loan agreements entered into by the Appellant. 19. It is submitted in this regard that the additional interest for the period of default has been variedly termed in the loan agreements as 'penal interest' / 'default interest' / 'late payment penalty', however, the same does not change its nature from being 'interest' only. It is a settled principle in law that the nomenclature alone would not determine the nature of transaction. In this regard, relianc....
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....eriod of delay not included in the EMI/instalment amount. The Ld. AAR further recorded a finding that rate of interest of loan and the penal interest is different, and in general course of business, the interest charges are fixed at a certain rate, however, the penal interest has been defined in the loan agreement to be "not exceeding 3% per month". The Ld. AAR further recorded a finding that the penal interest which is termed as additional interest is also levied on the interest component of the EMI. 24. The above findings are based on an incorrect understanding of the facts of the present case. In this regard, it is relevant to note that the Ld. AAR has not disputed that the interest which is factored in EMI fits into the meaning and scope of interest of loans, therefore, the rate at which such interest is payable is not relevant to determine the nature of such transaction. The Ld. AAR has failed to understand the commercial reality of the financial transactions. It is submitted in this regard, that there are many ways of determination of the rate of interest, which includes flat interest rate, reducing balance rate, etc. However, in any case, the interest is, in effect, the c....
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....onal interest for the period of delay in making payment of the EMI. Further, the Ld. AAR himself has admitted that penal interest is levied on the interest component of the EMI. This also substantiates that the defaulted EMI (principal and interest) virtually amounts to a new loan, in as much as penal interest is charged on the defaulted EMI (which is inclusive of interest) for the period of default. Hence, the penal interest shall be treated as interest only, and therefore, the above mentioned findings of the Ld. AAR are erroneous and bad in law. 27. In view of the above discussions, it is submitted that Penal Interest collected by the Appellant is additional interest only, therefore, any treatment given to the main consideration, i.e. interest on loans, shall also be equally applicable to the penal interest. Hence, the penal interest shall be exempted from payment of GST under the Exemption Notification. 28. In this regard, reference is also made to UK VAT Notice 701/49: Finance issued under the UK VAT law, wherein the charges levied for deferment of payment beyond the time of supply have been treated as consideration for an exempt supply of credit. The relevant portion ....
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....hall be applicable to determine the value of such exempt supply. It would be incorrect to say that the provisions of Section 15(2) are not applicable for exempt supplies, in as much as, the valuation of exempt supplies is equally important as that of taxable supplies, as the quantum of reversal of input tax credit under Section 17(2) of the CGST Act is determined on the basis of the value of exempt supplies. Hence, the provisions of Section 15(2) are applicable to determine the value of exempt supplies as well. 33. In view of Section 15(2)(d) of the Act, the penal interest levied for delayed payment of loan dues/EMl, being an interest/penalty for delayed payment of consideration, is to be included in the value of loans, which is nothing but interest only. Therefore, the penal interest so levied by the Appellant would be treated at par with interest, and any treatment given to the main consideration (i.e. interest) shall also be equally applicable to such amount (i.e. penal interest). Hence, the penal interest would be exempt from GST under Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. In any case, the penal interest charged by the Appellan....
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....le to GST. 38. It is submitted that the present case of penal interest collected by the Appellant is neither a case of import, nor, is covered in the list of activities specified in Schedule l. Therefore, clause (b) and clause (c) of Section 7(1) of the CGST Act are not applicable in the present case. Further, as submitted above, clause (d) is only for the purpose of determination whether a particular activity is a supply of goods or supply of services. Therefore, it is relevant to first determine whether a particular activity is covered within the scope of clause (a), (b) or (c) of Section 7(1) of the CGST Act. In any case, the penal interest collected by the Appellant is also not covered under clause (d), as explained in detail in the submissions made below. 39. In this background, it is necessary to understand whether the penal interest collected by the Appellant constitute a supply for consideration under clause (a) of Section 7(1). In this regard, it is relevant to refer to the definition of the term 'consideration given in Section 2(31) the CGST Act as under: "(31) "consideration" in relation to the supply of goods or services or both includes- (a) any....
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....or an activity must be at the desire of the other person. 45. However, damages for the breach of contract cannot be treated as a consideration for any activity. It is submitted that upon breach of contract, the aggrieved party is entitled to claim compensation for breach of contract. Such compensation is a legal and statutory right provided under Section 73 and 74 of the Indian Contract Act, 1872, and even without any specific clause in the contract for the damages or compensation payable upon the breach of contract, the party suffering such breach has the statutory right to claim damages or compensation from the party who has broken the contract. 46. The provisions of Section 73 and 74 are extracted herein below for reference: "73. Compensation for loss or damage caused by breach of contract. - When a contract has been broken, the party who suffers by such breach is entitled to receive, from the party who has broken the contract, compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. ....
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....erest is charged from the customers from the date of default, so as to deter the customers from making such default in future. Therefore, looking from this angle, the penal interest charged by the Appellant may be treated as penalty for the breach of the contract. In any case, if it is held to be not penalty, then, the same shall be treated as liquidated damages. 52. Therefore, in view of the above discussions, it is submitted that the penal interest charged in the present case shall be treated either as penalty or liquidated damages. 53. In fact, the Ld. AAR has also accepted the submissions that the penal interest is in the nature of penalty. Therefore, in this background, it is relevant to understand whether the amounts recovered in the nature of damages or penalty amounts to supply. The same has been explained in the submissions made herein below. 54. It is submitted that payment of liquidated damages or penalty is not a consideration for any supply, as they are merely damages for the breach of contract. It is submitted in this regard that the stipulation for payment of damages upon breach of contract does not constitute a separate contract; it is a part of the origina....
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....t committed by the borrowers by way of delay in payment of EMI/ installment is being tolerated by the Appellant and is therefore covered under clause (e) of Entry 5 of Schedule II to the CGST Act. 60. For the sake of reference, the above said entry is reproduced herein below: "5. Supply of services The following Shall be treated as supply of services, namely: (e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act; and" 61. It is submitted that the Ld. AAR has misinterpreted the above clause to allege that any act of tolerating would fall under the ambit of the said clause. The correct interpretation of the law would be to read the above said clause as under: (i) agreeing to the obligation to refrain from an act; (ii) agreeing to the obligation to tolerate an act or situation; (iii) agreeing to the obligation to do an act. 62. It is submitted that the expression "agreeing to the obligation" is a prefix to all the three entries, viz. 'to refrain from an act', 'to tolerate an act or a situation', and 'to do an act'. Therefore, to attract the above said clause, there mus....
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....which constrains a person to do or suffer something; it implies a right in another person to which it is correlated, and it restricts the freedom of the obligee with reference to definite acts and forbearances; but in order to be enforceable, it must be an obligation recognised by law; and not merely a moral, social or religious one. An obligation may not be a legal one, where it cannot be reduced to a money value; legal obligation includes every duty enforceable by law so that when a legal duty is imposed on the person in respect to another, the other is invested with a corresponding legal right. This definition is used in its wider juristic sense as covering duties arising ex contractu or ex delicto, and may cover any other enforceable duty under any statute." • Black's Law Dictionary: "Obligation, (n.) 1.A legal or moral duty to do or not do something. The word has many wide and varied meanings. It may refer to anything that a person is bound to do or forbear from doing, whether the duty is imposed by law, contract, promise, social relations, courtesy, kindness, or morality. 2. A formal, binding agreement or acknowledgement of a liab....
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.... of the above discussion, it is submitted that in the absence of an agreement by the Appellant to any obligation to tolerate an act of non-payment or delayed payment of loan installments by the borrowers, the mere recovery of penal interest for breach of the contract does not constitute a supply of service by the Appellant to the borrower. 71. It is therefore submitted that the findings of the Ld. AAR that the Appellant has tolerated the act of default of the borrower which falls under clause 5(e) of Schedule Il, is based on an incorrect interpretation of the law, without considering the meaning of the expression 'agreeing to an obligation' used in the said provision. 72. Hence, the impugned AAR order holding that the penal interest is consideration for tolerating by the Appellant is bad in law and is liable to be set aside. Even internationally, the damages for breach of contract are not taxed. 73. It is further submitted that internationally, the damages received by way of compensation for termination or breach of a contract are not treated as a supply and therefore not subjected to GST/VAT levy. 74. In Australian Law, the GST is levied on supply under 'A New Tax S....
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....current supply, cannot be said to be made in connection with any supply. The lessor merely exercises his right to terminate and the payment is in the nature of damages for the lessee's breach of the lease which gave rise to the lessor's right to terminate. Thus, in the above Ruling issued under Australian GST, it has been clarified that mere payment of an amount under a damages claim is not a 'supply' and hence, GST is not payable on such supplies. 78. Further, reference is made to GST Determination No. 2005/6 which has been issued to answer the question as to whether a club, association, trade union, society or cooperative (referred to as "association" in the Determination) makes a supply when it imposes a non-statutory fine or penalty on a member for a breach of the association's membership rules. The said GSTD clarifies that there is no supply made by an association when it imposes a fine or penalty on its member for a breach of its membership rules, and the payment of the fine or penalty is therefore not a consideration for a supply and hence not leviable to GST. It has been clarified in the above GSTD that if the true nature of fine or penalty is a punishment and/or to act ....
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....Appellant. When such terms and conditions are not fulfilled, the defaulting party is obligated to make good the loss by paying liquidated damages. Such liquidated damages/penalty cannot itself become consideration for continuing with the main supply of service/goods by terming the same as towards tolerating the acts of the defaulting party. 83. Thus, liquidated damages/penalty are merely for making good the loss suffered by a contracting party due to breach of terms of the contract by other contracting party. There is no additional benefit given under the main contract of supply of service, in return for the liquidated damages/penalty. 84. The ratio laid down in the above discussed rulings shall be equally applicable for determining the taxability of penal interest in the present case, as the provisions of Entry 5(e) of Schedule II to the CGST Act are similar to the GST/VAT laws of other countries, and the scope of 'supply' in such laws is wide enough to cover an obligation to tolerate an act or situation. 85. Hence, by applying the above rulings, it can be concluded that the penal interest collected by the Appellant in the present case, being penalty/liquidated damages fo....
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....ed new loan amount (i.e. the defaulted EMI) are different. 88. On perusal of the above, the issue before us, to decide, is whether the penal charges / penalty collected by the Appellant from their borrower customers who have defaulted EMI and delayed the payment of EMI, is for tolerating any act as envisaged under the entry 5 (e) of the schedule II to the CGST Act, 2017, or is in the nature of additional interest, and therefore, covered under the entry 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017 and not subjected to GST levy. 89. To decide this issue, we have closely examined the copies of the agreements placed before us and we find certain clauses are necessary in order to determine the nature of charges collected by appellant for delay in payment of EMI. The relevant extract of clauses of a sample auto loan agreement in respect of penal charges is reproduced below for ease of reference: 1. Definitions and abbreviations: e. "Default Interest" means interest levied by BFL from the due date till payment on happening of any event of Default as set out in clause 3 (iv) of this agreement. q. "Penal Charges" mean and include ov....
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.... is an NBFC which is engaged in providing various types of loans to the customers the interest on loans have been kept outside the levy of GST, under Serial No. 27 of the Notification No. 12/2017-Central Tax (Rate) dated 28.06.2017. The above said entry 27 of Notification is reproduced herein below: Sl.No. Chapter, Section, Heading, Group or Service Code (Tariff) Description of Services Rate (per cent.) Condition (1) (2) (3) (4) (5) 27 Heading 9971 Services by way of- (a) extending deposits, loans or advances in so far as the consideration is represented by way of interest or discount (other than interest involved in credit card services), Nil Nil In view of the above, it is evident that services of providing loans are exempt, in so far as the consideration of the said services is represented by way of interest. The term 'interest' has been defined under clause (zk) of para 2 of the above said Notification, which reads as under: "(zk) "interest" means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) but does not include....
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....efinition contained in another. In view of this, the reliance placed by appellant is said to be is misplaced. On the other hand, we have to strictly abide by the meaning given to it by the Legislature, as in the present case. The definition provided in clause 2 (zk) of the notification defines interest only to mean interest in respect of any moneys borrowed or debt incurred but does not include any other charges in respect of the moneys borrowed or debt incurred. Hence, we cannot give it an extended meaning as contended by the appellant. 93. A perusal of the method of calculation furnished by appellant shows that it is calculated on the entire due amount of EMI, including interest already included therein EMI. But, as claimed the interest cannot be levied on interest, but only penalty can be levied on the interest not paid within the due date prescribed for it. The real substance of the transaction is that the payment of penalty / penal charges is on account of the failure of the customer to adhere to the conditions of repayment of EMI as stipulated in the Agreement. Thus, the nomenclature provided in the agreement is not the only deciding factor to construe it as penalty / pena....
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....d apply in these cases where interest is not defined separately anywhere else in a specific context. A separate carving out of the word 'interest' in the notification in the context of this case sets it apart from drawing a general meaning from Section 15. 96. Having rejected the above contention of the appellant, the true nature of the issue has to be seen now in the light of the entry 5 (e) of the schedule II to the CGST Act, 2017. Therefore, we will go through the entry 5 (e) of the schedule II to the CGST Act, 2017, which has been reproduced herein under: "(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act;" In the instant case, the Appellant enters into loan agreement with the borrower. On perusal of the sample agreement, it is observed that it contains specific clauses namely 'Events of Defaults' and 'Remedies in case of Defaults'. The relevant portion of these clauses from sample auto loan agreement are reproduced herein below: 25. Events of Defaults: A default shall be deemed to have been committed if the borrower does not comply with its obligation covenants contained in this agreeme....
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.... the Appellant and the borrower. Thus, here it can be said that the Appellant have tolerated an act or situation of default by the borrowers, for which they are recovering some amount in the name of the penal charges / penalty. Hence, such activity of tolerance is against consideration. As regards the contention of the appellant that there is no separate agreement, we are of the view that though there is no separate agreement between the Appellant and the borrower, for the said act of tolerance of the delay by the borrower, there is clear provision laid out at entry 3 (a) of the above discussed agreement, in this regard, in the loan agreement itself which clearly proposes the remedy available for the default by the borrower. Thus, this argument of the Appellant is devoid of my rationale or merit, and hence is not worth considering. 98. The appellant further contended that it is relevant to first determine whether a particular activity of the appellant is covered within the scope of clause (a), (b) or (c) of Section 7(1) of the CGST Act as the Clause (d)only provide to treat said activity as either supply of goods or as the case may be supply of services. The appellant has made t....
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....ivity in the form of expression "to tolerate an act or a situation" and thereby an act of tolerating delay in payment of EMI is brought into ambit of supply by treating it as supply of services. There shall not be confusion in the mind of anyone that legislature intentionally brought this activity of tolerating an act in the scope of supply of services. 100. As explained herein above paras the appellant received the consideration and tolerated the act or situation of delay in payment of EMI. In view of these facts the harmonious and purposive interpretation of the above referred Clauses under subsection (1) of Section 7 of CGST Act is that they are dependent upon the other and conjoint reading of Clause (d) and (a) of the section 7 (1) remove all clouts of doubt and make it absolute clear that such an act of tolerating delay in payment of EMI is nothing but supply as mandated under Section 7 of the CGST Act. 101. The Appellant has repeatedly submitted that the penal interest recovered by them from their borrower cannot be considered as consideration, as the same is not received by them for supplying any specific service to the borrowers. It is rather in nature of damage or co....
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....e payment of penal interest neither obligates the Appellant not to take any legal action against the borrower, nor the does the borrower gain any right to sue the Appellant for any legal action taken by the Appellant. In this respect the appellant in his grounds of appeal has also submitted that the Ld. AAR has misinterpreted the above clause 5 (e) of Schedule II and interpretation of clause 5 (e) submitted by Appellant in this regard is that it shall be read as under: (i) agreeing to the obligation to refrain from an act; (ii) agreeing to the obligation to tolerate an act or situation; (iii) agreeing to the obligation to do an act. Being, the expression "agreeing to the obligation" is a prefix to all the three entries. 103. We believe that the here the appellant has tried to play with words and coined a new theory of interpretation the law. In common parlance the prefix is a group of letters placed before the root or stem of a word or part of a word that is placed at the beginning of another word to change its meaning. By this logic prefix cannot be said as group of words as stated in submission by appellant. However, the construction of the ....